Earnings Call: Q2 2021

Aug 19, 2021

Thank you for standing by and welcome to the 360 Digitech Second Quarter 2021 Earnings Conference Call. Please also note today's event is being recorded. At this time, I'd like to turn the conference call over to Ms. Mandy Dong, IR Director. Please go ahead, Mandy. Thank you. Hello, everyone, and welcome to our Q2 2021 earnings conference call. Our results were issued earlier today and can be found on our IR website. Joining me today are Mr. Wuhai Shen, our CEO and Mr. Alex Xu, our CFO and Director and Mr. Zheng Yan, our COO. Before we begin the prepared remarks, I'd like to remind you of our Safe Harbor statement in our earnings press release, which also applies to this call. We may refer to forward looking statements based on our current plans, estimates and projections. Also, this call includes discussion of certain non GAAP measures. Please refer to our earnings release for our reconciliation between non GAAP and GAAP ones. Unless otherwise stated, figures mentioned are in RMB. I will now turn the call over to our CEO, Mr. Hello, everyone. I'm very happy to report another quarter of record breaking operational and financial results. During the quarter, financial institutions originated RMB88.5 billion loans through our platform, marking another record high, After reaching RMB100 1,000,000,000 milestone in Q1, outstanding loan balance continued to grow to RMB111 RMB0.6 billion in Q2, up by 0, 50 percent Y01 and the 15, 15 percent Q on Q. Total revenue was RMB4 1,000,000,000 in Q2, up 20% to 0 YOY and 11% Q on Q. Non GAAP net income was RMB1.62 billion, up 71% Y0115 Q on Q. Despite the continuously changing In the regulatory environment, we have delivered 5 consecutive quarters of record breaking results. Over the past few years, We have built a comprehensive operational system that demonstrates remarkable resilience through the cycles. To be more specific, Our diversified users acquisition channels and scenarios allow us to effectively hedge against any volatility for a particular channel. Our extensive network of diverse financial institution partners give us sufficient flexibility in terms of funding cost, Geography coverage and the pricing. Our full spectrum risk management capabilities allow us to target different user segments With effective pricing based on different market dynamics, our access to some key financial license Also give us ecosystem great flexibility to comply with the ever change regulatory environment. Over the last 6 weeks also, Qilin along with other Chinese ADRs has experienced extreme volatility in the market. While there are multiple risk factors trigger such as share price movement, we believe the market is over to the negative elements and ignoring the solid fundamental and the strong growth prospect of KYLFIN. As such, after CAF evaluation with the approval of our Board, management decides to launch a share buyback program. The company intends to repurchase up to US200 $1,000,000 of its ADS through open market or other form of transaction Over the course of next 12 months, we believe at current market condition, share repurchase offers extremely attractive opportunity To exploit our cash and to generate great returns to our shareholders. We continue to make progress Multiple strategy initiatives and gradually unlock tremendous growth opportunities. We made significant progress on diversified The number of new borrower in Q2 hit the highest level in the past 6 quarters, up by more than 10% Sequentially, the number of SME borrower acquired off line also increased significantly. Our embedded finance model contributes Close to 40 percent of our new customers with approved credit lines in Q2. So far, we have established cooperation with 22 leading traffic platforms with another 8 in the pipeline. Our SME Finance Business also achieved a breakthrough performance in Q2 by strengthening our ties with the leading industry partners and optimizing credit RMB7.1 billion and outstanding loan balance increased 45% sequentially with average ticket size exceeding RMB 250,000. Meanwhile, we are rolling out customers' loan products catering to the spending needs of different industries. In July, we launched tobacco business loans and have served more than 700 offline tobacco business owners. In the second half of this year, We plan to launch other industry specific loan products targeting cross border e commerce, supply chain finance as well as agriculture and forestry sectors. Loan facilitation under the Capital Light model accounted for roughly 56% of total volume in Q2. For the month of July, Capital Lite accounted nearly 60%, 6 0%, almost reached our full year goal for tech upgrading strategy. For our smart marketing product, ICE, intelligence credit engine, the number of active users increased 74% Q on Q. The transaction volume and outstanding balance both went up by 36%. As for the recent regulatory change, we want to share a few thoughts here. As one of the 13 leading Internet platform on the April 29 regulatory meeting, We have maintained regular and the close communications with regulators. Currently, the self assessment and the related rectification process Moving forward in an orderly manner, we fully understand the regulators' requirements and expectations for the industry. Overall, our business is relatively focused and has a clear path towards full compliance with regulatory requirements. We don't have online payments, online insurance or online brokerage operation, which are subject to more restrictive regulations. For our loan facilitation business, we don't do joint lending nor have overleveraged ABS insurance. Thus, we are highly confident to satisfy all of the revised regulatory requirements when everything is set and done. As you may already know, the proposed new regulation will not allow loan facilitation platform To provide credit assessment related data directly to financial institution and such data transfer And to make necessary preparations, we will take multiple actions to satisfy this new regulation. On one hand, we can cooperate with existing third party credit agency. On the other hand, we can also seek partners to jointly launch a NIO credit agency. Recently, some media reports indicate that regulators will require consumer finance companies to implement an All in interest rate cap of 24% for consumer lending. This is consistent with the regulators' long term agenda to support real economy by lowering financing costs for consumers and SMEs. This is also consistent with our long term business planning. Our own balance sheet loan and SME loan business already priced below 24%. For our consumer facilitation business, Even under a more restrictive stress test in which we assume to cut our price to below 24% rather rapidly, We do not expect the price cut to have a meaningful impact to our operational and financial results in 2021. As for 2022, it will be a transitional year when the entire industry will comply with the 2024 rate cap by June 18th. In our stress test, we continue to see healthy volume growth in 2022 and net take rate should be around 3%. There are also some positive factors that may mitigate negative impact from the 24% rate cap. With lower price, We should be able to develop a partnership with larger national banks that typically offer more stable funding at lower funding costs. In addition, with all of our assets at 24% or lower, we should be able to significantly increase the issuance of ABS, which typically carries a much lower funding cost around 5% to 5.5% versus around 7% from banks. Furthermore, at lower prices, we can attract more high quality borrower, which will naturally drive down overall credit cost by 1% to 2% point on IR basis. Finally, based on our experience, lower pricing normally boosts the borrower activities, would come along with lower priced products. This will ultimately enhance our operational efficiency and make our business more resilient and sustainable. Such change may set up a solid base for us to accelerate its Growth after 2022, we feel quite optimistic. I would now like to address the temporary removal of our 360 DHL app from App Store. The removal was due to our product engineer missed out one of the function that was required by the regulators. We have already fixed the issue And our app has been restored to all major app store to the date. We have conducted A thorough internal review and improved our operating protocol to ensure such incident never happen again. Thanks to our diversified customer acquisition channel and the balance of product mix, the impact from app removal to our operation has been minimal. During the quarter, we continued to diversify our funding source. We accelerated the pace of ABS insurance With a total of RMB2.1 billion ABS in Q2 at an average corporate rate of 5.3%. This has brought our total ABS insurance to RMB3.1 billion so far this year, ranking us number 4 in the market. As our risk management system support more business lines, we continue to see further enhanced of our asset quality. The 90 day trust delinquency ratio across our platform was 1.19%. The M1 collection rate remains stable at 90.8% And day 1 delinquency rate at 5%. We continue to expand the scale of our collaboration with KCB. Total accumulated loan facilitation volume As of Q2 was RMB33.5 billion. Outstanding balance was RMB20.4 billion at the end of Q2, up 60%, six-zero percent from Q1. We expect the scale of the PCB partnership to remain relatively stable for the time being. We have deep rooted trust and raised flexibility in our collaboration with KCB. Going forward, we will proactively explore new products and the business opportunities through our cooperation with KCB. We made some good progress on the ES3 front, which drew more and more attention. When Dally floods hit Henan Province this July, we took swift action to support by donating RMB20 1,000,000 through the 360 Foundation. Meanwhile, we organized the local team to join the rescue efforts. Overall, we are quite satisfying with our performance in the first half of twenty twenty one. This fruitful result comes along from dedicated efforts of our Epsilon team. I would like to express my gratitude to their hard work. We are in a time of rapid changes and the great companies are always born In great strength, we have successfully demonstrated our capabilities and ambition over the past 5 years. FinTech is a best market with huge potential and the FinTech products have profoundly changed financial service landscape and the user experience. We will continuously launch innovative products and are dedicated to become the premium player in this market. Now let me turn to our CFO, Alex, to run through more detailed info. Thank you. Thank you, Haisheng. Good morning and good evening, everyone. Welcome to our quarterly earnings call. For the interest of time, I will not go over all the financial line items on the call. Please refer to our earnings release for the details. As Haisheng mentioned, we delivered robust operating and financial results for the first half of twenty twenty one, powered by strong consumer demand for credit and further improvement in asset quality. The strong business momentum appears continuing into current quarter. In fact, we have seen record breaking volumes in recent months despite some reported softness of microeconomic activities lately. Total net revenue for Q2 was RMB4 1,000,000,000 versus RMB3.6 billion in Q1 and RMB3.34 billion a year ago. Revenues from credit driven service, Capital Heavy, was RMB2.4 billion compared to RMB2.45 billion in Q1 and RMB3.08 billion a year ago. The year over year Time was mainly due to facilitation volume mix change as capital heavy contribution decreased significantly. Revenue from Path of Service, Capital Light was RMB1.6 billion compared to RMB1.15 billion in Q1, and RMB259,000,000 a year ago. The robust growth was mainly driven by Exceptional progress we have made in Capital Light and other technology solutions. During the quarter, Capital Light and other technology solutions Contributed roughly 56% of total loan volume, while the underlying take rates were relatively stable. We expect capital light contribution percentage to continue increase in the second half and to reach roughly 2 third of our total volume by the year end. During the quarter, average pricing was 27.2% compared to 26.6 percent in Q1 and 27.2 percent a year ago. Assuming The reported 24% rate cap guideline will be implemented across industry. We are expecting overall Even under the more restrictive and steep rate cut scenario, where we assume we cut the rate to below 24% starting from September 1. In such scenario, we should and resume to a more robust growth afterwards. As microeconomic activities picked up in China in the first half, Demand for Internet traffic also increased significantly along the way. In addition, We also proactively accelerated the pace of customer acquisition in recent in the last couple of quarters to take advantage of the overall positive business trend. As such, we have experienced some uptick in sales and marketing expenses. Average customer acquisition cost on the consumer lending side for the quarter was about RMB237 compared to RMB206 in Q1. As we discussed in the past, average cost per proved credit line is a calculated number with limited value in our decision making. We will continue to use lifecycle ROI and LTV as key metrics to determine the pace and So far in 2021, Healthy ROI trend have encouraged us to take a more proactive approach to accelerate the growth of our customer base. Non GAAP net income was CNY1.61 billion in Q2 versus CNY1.41 billion in Q1 and RMB 942,000,000 a year ago. We once again set a new record in quarterly profitability, driven by higher facilitation volume and noticeable improvement in asset quality. Effective tax rate was approximately 18% for the quarter and sorry, for the first half of twenty twenty one. We see similar level of ETR for the rest of the year. Longer term, we are expecting our normalized ETR to return to approximately 15%. As we move towards a more technology driven business model, We continue to see marked improvement in operating margins as increasing contribution With strong operating results and increased contribution from Capline model in Q2, our leverage ratio, which is defined as risk bearing loan balance divided by shareholders' equity, further declined to 4.8 driven by further movement toward capitalized and solid operating results. Total cash and cash equivalent was RMB8.8 billion in Q2 compared to RMB9.2 billion in Q1. Non restricted Cash was approximately RMB5.2 billion in Q2 versus RMB6 1,000,000,000 in Q1. The modest decline in cash was mainly due to more proactive deployment of cash in our operations to support ABS and the pre ABS assets, which generates higher returns. Meanwhile, a significant portion of our cash also allocated was also allocated to secured deposit with our institutional partners and register capitals of different entities to support our daily operation. As we continue to generate Strong cash flows through operations, we believe our current cash position is more than sufficient to support the expansion of our business to invest in key technologies and to satisfy potential regulatory requirements. Therefore, we believe it is a prudent decision to use some of our free cash to invest in our own stock, which is priced just around the company's liquidation value. For a company that is still generating healthy growth for the next few years, we believe it is a great bargain. Finally, let me give you some update about our outlook for 2021. The operating results for the first half of twenty twenty one Well, very encouraging and the momentum doesn't slow so far in current quarter. Although we intend to keep our tradition of a conservative approach in providing forward Guidance, the numbers start to speak for themselves. As such, we would like to raise our 2021 total loan volume guidance to be between RMB340 1,000,000,000 and RMB350 1,000,000,000 compared to previous guidance of RMB 310,000,000,000 and RMB330,000,000,000. The revised guidance represent Year over year growth of 38% to 42%. As always, this forecast reflects the company's Current and preliminary view, which is subject to material changes. With that, I would like to conclude our prepared remarks. Operator, we can now take some questions. Thank you, management. Followed by English translation. Our first question is from Richard at Morgan Stanley. Please go ahead. Basically, two questions from me. One is on the basically sending borrower information through the credit scoring agencies. Any detailed discussion on the actual process, because it's been a little while and You mentioned basically there has been further discussion and there's different versions out there. I just want to see what is the latest development on that front. Secondly, it's obviously very good loan volume. Any discussion with the regulators in terms of any views and window guidance on the pace at the proper pace. Thank you. Okay. So for the draft version of regulation and the administration of credit assessment business was announced and we have been communicating with regulators For a long term, but actually in the market that there is no standard solution available so far for now. And also as Mr. Zhen has mentioned that actually there are 2 or 3 solutions that we care about. The first one is that We applied for credit lessons to launch a new credit agency. And the second one is we cooperate with existing credit agency to continue our business. Also, with our in-depth cooperation with KCB, which offers us another alternative So for your second question regarding to our growth rate, Actually, we have seen that the growth is not the problem and the regulators focus more on the standardization of the product and our business. Also, we have seen that in the requirement by the regulators, they have issued that they want the platforms, Internet Thank you. Our next question is from Alex Xie at UBS. Please go I will briefly translate my question. First one is on the regulatory development. So It looks like the current direction from the regulators is continuing to tighten the very first As part of the data collection by the Internet company, so I'm wondering, Assuming the regulators issue more stringent regulations on consumer data collection and use in the future, How would that affect our current practice of data collection and use? And how would that affect our credit model? Second question is on your Plan to work, complying with the 20% interest rate cap. So you mentioned that in your stress test, you are going to comply fully comply with the 20% cap by This year, but so if that's the stress test, then what's your base case or your target trajectory to Combined with that new cap. And then the first question is also related to the interest rate trend. So there are market concerns about the 20% cap is only just the beginning of the future regulatory requirement of further Pushing down the overall lending rates. So I'm wondering if you have any comment on that. And specifically, given you're also Ramping up your SME loans, so it looks like this segment will be subject to further pressure From lower rate, no guidance. Also, we appreciate your comments. Thanks. Okay. Thank you, Alex, for your question. So regarding to your first one, Actually, we see it's happening as well about the data capture and usage in this industry. So for regulators We think there are 2 basic principles. The first one is the minimum standard for data capture. So apart from capturing data from customer side, like for customer forums or application, we are working proactively with 3rd party credit agency for And the second principle is that the customer authorization is mandatory before data Captured. As you may know that our removal of our 360 JTiao application from app stores was caused by these problems. So we will emphasize more on this principle in the future. We believe that with our relatively standard process And the impact of this tightening principles will have minimum impact on our business. Regarding to your Second question, the timeline of the all in interest rate cap of 24%. Actually, we say that there are And the time lines for different institutions, some institutions will follow the guideline that the outstanding balance Of the loan, over 24% will be reduced to 0 by end of June next year And some institutions follow the guidance that there will be no new originations by June next If the 24% interest gap will be lowered more, actually as all market participants know, 24% interest gap Has been the window guidance from regulators to banks for a long time. Recently, media reports speculate that base interest cap This requirement extends to consumer finance components. Since the 24% cap has existed in the industry for And furthermore, regarding to the interest rate of SME loans, of course, regulators want to say the interest rate to be as lower as possible, but there is no standard. As it is similar to the consumer finance industry, there are different and various needs and supplies of SME loans. As a platform, as intermediary, we will continue to offer the various services to meet different kinds of needs of the SME loans. Thank you. Thank you. Our next question is from Jackie Chu at China Renaissance. Please go ahead. So let me translate. So Congrats for the strong results. My first question is related to regulation as well. So for the 24% interest rate Management gave a stress test for next year regarding the margin. Probably it will go down to 3%. So just want to understand what is our assumptions behind the stress test regarding to APR funding costs and credit costs and other expenses, and any We can give an outlook for APR in the Q3. And second question is regarding to the SME loan. We've seen other competitors also move to this new business. So How are we going to differentiate our SME loan products? And what is the APR margin and our growth target this year? And is this SME loan included in our new loan volume guidance? Thank you. Thank you, Jackie. Regarding to your first question about the stress test, actually what we have delivered now is a relatively static With all other factors status quo, especially there is no improvement in our efficiency. So We estimate there is no cost changes in this version of the stress test. However, as we have known that there is a Improvement of our cost. For example, for our funding cost, before we have a large portion of However, with a lowering cap interest rate, we can have more funding from national banks Larger national banks and we can increase our ABS volume. So we expect our funding costs to be lowered by 1%. And we have the credit loss expectation to be lowered by around 1% as well. For another major cost, the customer acquisition cost will lowered as well. So we expect that actually the take rate of 3% will be improved in the future. For the Q3 of this year, we have started the lower APR So the API will be lowered, but there will be no meaningful impact on our financial results of the next quarter. So for your second question regarding to our competitiveness of SME loans, so there are Two aspects. The first one is about risk management. Our SME business is different from the traditional ones We focus more on the MSE side. Considering the traditional SME loans are over 10,000,000 ticket size It's not fully data driven. However, we have adopted a dual engine regarding to our risk management about SME loans. That is, we evaluate from the individual side and from the corporate side. With ticket size of 250,000 on average, We have used and fully utilized our accumulated experience on risk management in the past years on consumer finance. And the second advantage of us is the cooperation with KCB. As the only 3 platforms in China market Regarding to the SME business. So for our target of SME loans this year, it will account for around 10% to 15% of our total loan origination and it has been covered in our guidance. Okay. Jacky, just I have a few Sort of a clarification and add up to Mr. Wu's comments there. Number 1, the most important clarification that 3% is not a margin, It's the take rate, right? Our net margin this quarter was 40%. And if anything, for the next couple of quarters, probably see a little bit expansion of net margin than this Q2. So the 3% though is the take rate On loan balance, that's we have been saying this in the past. And then secondly, And also regarding the second half pricing trend, even though we our stress test was taken a more drastic Starting from September 1, basically on that day, everything goes below 24. But in reality, That's not going to be the case. Just like Ai Sheng mentioned, it's really dependent on the pace of our financial Institution partners, they're kind of a progress there. So most likely, it will be a gradual trending down toward that Kind of a goal by the end of June of next year. So if you do a linear kind of On any given quarter from now to the mid of next year, you're probably looking at maybe 1 percentage or a little bit over 1 percentage Point change in pricing, if you just average out. So that's the regarding the pricing change. And then this kind of a change For 2021, for the remainder of 2021, we don't see any kind of a meaningful impact in I mentioned that the second half probability will most likely keeping pace with the loan volume growth. You have our guidance for the full year. You can do the calculation roughly get the calculation sorry, the probability number for the second half. So that's the another clarification. Then the third point is really about how do we get that 4% sorry, 3% take rate When this whole thing is said and done. I have a kind of a back end of the envelope calculation. Let's assuming our current mix In terms of Cap Light versus Cap Heavy at 60 versus 40, 60 being the Cap Light. And normally, The reality is our cap light side of business carry a higher pricing versus the cap heavy. So if we, let's say, cut all the pricing to 22.5%, Then on the cap heavy side, we need to cut roughly about 2%. On the caps life side, we need to cut Roughly about 6.5% to 7%. But keep in mind That 6.5% to 7% cut is actually the overall cut. Remember, we are only taking 30% of that sharing. So 6% to 7% cut to us is only 2% in real impact, right? So essentially the cap light and cap heavy, basically, You have a similar 2% impact just by the pricing alone. That's a pretax impact. If you add the tax rate on it, The net impact on the pricing alone will probably be somewhere around 1.7%, 1.8%, maybe, okay. So that's a pricing loan. And then forget about the funding cost savings, the operational efficiency and all these kind of things. The one clear change will be the risk factor, just simply because when the pricing coming down, you are naturally targeting a high quality group of users. Okay. For that, by our estimate, the savings from after Tax savings from that sort of a credit cost side will be coming somewhere around 0.6% to 0.8% range. So So if you deduct the pricing impact, 1.7 deduct a 0.8 sorry, 0.6% to 0.8% from the 1 point 7% to 1.8%, you get roughly 1%. That's not even considering anything on the funding cost, On operational efficiency and all the other things we actually mentioned earlier. So that's the very rough calculation just for your reference. Thank you so much. That's the end of the Q and A session. I would like to hand it back to to management for briefing closing remarks. Okay. Thank you, everyone, again to join our conference call. And if you have any additional questions, please feel free to contact us. Thank you. Thank you. Operator, shall we stand up? Yes. That's the end of the conference call.